Glossary
Hedge fund
A privately offered pooled fund for accredited investors that can use leverage, short selling and derivatives, usually with performance fees.
On this page
A hedge fund is a private investment partnership that pools money from wealthy individuals and institutions and invests it with few of the restrictions placed on public funds. Managers can use leverage, short selling, derivatives, concentrated bets and hard-to-sell assets. Despite the name, many hedge funds do not hedge much at all; the label describes the legal structure and fee model more than a strategy.
How it works
In the US, hedge funds avoid registering as investment companies by relying on exemptions in the Investment Company Act of 1940, which limit who may invest. Most sell only to accredited investors, for example individuals with income above $200,000 ($300,000 with a spouse) in each of the last two years or net worth above $1 million excluding their primary residence. Funds for even larger investors may require "qualified purchasers," generally individuals with at least $5 million in investments. Investors typically face lock-up periods and can redeem only monthly or quarterly with advance notice.
Strategies range widely: long/short equity, global macro, event-driven, merger arbitrage, credit, quantitative and multi-strategy "pod" platforms.
Fees
The traditional model is "2 and 20": a 2% annual management fee on assets plus 20% of profits as a performance fee, often above a high-water mark so that past losses must be recovered first. Many funds now charge less, but some top performers charge more.
What to keep in mind
Hedge funds disclose far less than mutual funds. Managers with more than $100 million in US equities do file quarterly 13F reports, but these omit short positions. Average industry returns after fees have often trailed simple stock-and-bond mixes, while the dispersion between the best and worst funds is very large.